VARDAMAN VIRTUAL FORESTRY COMPANY

The Most Direct Link to Knowledge Workers in the Southeast Forest Economy

HOW TO MAKE "REAL" MONEY GROWING TREES IN THE 1990S

I am especially delighted to appear before you because you have several advantages over competing investors in timberland. One should be obvious: you have the necessary capital to make them.

Another advantage may not be obvious: by being here, you have taken the first step to understand a complicated business. Dr. Richard Feynman, Nobel Prize winner in physics in 1965 who played a key role in developing the atom bomb, described this step very well when he spoke before BBC cameras and a group of students: "Sometimes the explanations of physics can look easy because you'll ask me a question the explanation of which requires only knowing something that you already know. Then I can explain how it works. Other times you want more details and the explanations involve something that's true but you don't happen to know about. [Then] I have to say that this is an element that you'll have to learn in order to be able to understand. If you ask that four hundred years of an activity should come down to things you can understand in a few minutes, you're asking a lot." By being here, you've made my job much easier.

A final advantage may not have occurred to you at all: because you are experienced investors, you know how important management is and how important it is to make decisions and act in a timely manner. Many of your competitors lack this knowledge almost completely, so they can't make up their minds, dilly-dally around until it's too late to do things right, thereby contributing to their own failures and later providing opportunities for good purchases.

The next step in our work here is to feed the outputs of PTAEDA2 into calculations of return on investment. As a start, I want to define two terms. One is site index, the main indicator of an acre's productivity; here we will use SI-25, total height of the main trees in a stand at age 25. Another is real rate of return (RRR); here we will assume that, since timber is a commodity, its price will fluctuate in sync with inflation and thereby compensate for it and that increases in timber volumes will produce real returns in addition to the inflation rate. And to keep things simple, we will further assume that timber prices will not change from present levels. I'll get back to this last assumption just before I finish.

You won't be able to fully comprehend important steps in development of these plantations unless, in addition to watching the video, you examine the dimensions of the trees in them as predicted by PTAEDA2, the basic G&Y model.

First I shall run through a comparison of the key outputs of PTAEDA2 simulations of two typical plantations. The plantations differ only in number of trees planted per acre: 363 at a spacing of 12x10 in one, 680 at spacing of 8x8 in the other. Otherwise, they are identical: SI of 65, site-prep by burning, 15% hardwood in the canopy, a thinning at age 13, and harvest at age 23. Here are the two stands after the 13th growing season:

Now I want to point out several important characteristics:

1. Note that survival of the original trees is 87% in 363 and 79% in 680, so more of the establishment cost is still alive and producing wood.

2. Average DBH is 6.3" in 363 and 5.4" in 680, so the larger size that will bring premium prices in the future is beginning to appear.

3. Average crown ratio (the percentage of total tree height in live limbs, which started out at 100%) has dropped to 44.9% in 363 and to 40.4% in 680. Since all of the food needed for growth must be produced in the needles, speeded-up growth cannot occur until the tree puts on more needles, and it usually does this by adding more live limbs. This takes time, however, so large responses to thinning are delayed. As a general rule the minimum crown ratio for acceptable growth rates is 35, so good managers plan from the beginning to keep stocking low enough to maintain this or a higher level. All of these statistics, which will cause 680 to be less valuable, are by-products of initial density of the stand and competition between its trees.

Here are the thinnings at age 13, the poor trees to be removed:

Note the difference in average DBH; it's 5.3" in 363 and 4.6" in 680. This means that the logger in 680 must process 68% more trees to get only 40% more volume, thereby increasing his costs and lowering what he can pay per cord for stumpage. Also notice that, in these generally less-vigorous trees of the stand, the crown ratios are 41.4 in 363 and 37.5 in 680. Here are the harvests at age 23:

Note that 363 contain slightly more sawtimber in slightly larger trees.

The next step in analysis is to translate these timber flows into cash flows. In a minute I'll show and discuss a schedule of all prices and costs used in my analyses, but for the time being, just accept as gospel the figures on the screen, all of which we got from our recent sales. Here are evaluations of thinnings and harvests, with 363 on the top and 680 on the bottom:

We obtain these prices by close questioning of bidders on our sales. Although most of them consider that their evaluation methods are secrets, they will usually answer such questions as" What would you have bid for this pulpwood if all trees had been 5" DBH? What if they had been 6" DBH? Or 7" DBH?"

One reason that stumpage price varies by DBH class is that logs or whole trees are often bought by weight at a fixed price per ton. Look at this schedule of weights per cord by DBH classes:

Cords from small trees weigh less because the sticks in them are necessarily smaller, which means that the cord contains more air and less wood. (Some persons think that smaller sticks will fit together more closely. To see why this is not true, think of a cord as one solid block of wood, 4' x 8' x 4'. Then split it with some sort of wedge. Now try to get the two new blocks back into the original cord dimensions. You'll see immediately that you can never get them together as tightly as they originally grew.) If the purchasing mill pays $0.01 per pound for pulpwood, you can see that 10" trees bring $48.76 per cord or 9.5% more than 5" trees.

The selling fees are the ones JMV&CO uses in most situations. The thinning fee percentage is high because of the large amount of work needed to prepare the sale and the low sale prices to which it is applied; although no cash flow is unimportant, thinnings mainly serve to remove poor-quality trees and to salvage potential mortality.

Here is the list of prices and costs that I promised.

Planting labor per seedling: $0.08 with dibble or machine

Seedlings of large size per M: generation cost plus $6

Control burn per acre: $6

Herbicide site-prep with helicopter per acre: $90

Herbicide release spray with helicopter per acre: $65

Annual income from hunting less annual management costs per acre: -$4

The regeneration costs shown are for common practices in the south. Several other treatments are used by others and us from time to time in different areas, but I omitted them here for the sake of brevity. I will come back to these costs after I cover the calculation of RRR.

Getting top prices like those listed, an essential prerequisite to earning high RRRs, requires skill in timber-selling technology. In a typical sawtimber sale, five steps are mandatory:

1. Measure DBH of each tree with a steel tape so as to know what you are selling.

2. Guarantee to buyers conveyance of so many trees by DBH class and species.

3. Publish dimensions of offered trees to enable buyers to make check estimates cheaply and to calculate volumes in other measures if they desire.

4. Ask for sealed bids.

5. Advertise sale to at least 200 buyers.

These five steps will produce results like these:

We recently got these 75 bids in a sale of 192 acres in Alabama that we divided into four blocks. We followed the mandatory five steps and asked for bids on land or timber or the two combined. The two high bidders are underscored. As you can see, opinions about value differed widely; some bid more for the timber by itself than others bid for both land and timber. The lesson here is "Never try to pick a buyer and negotiate; ALWAYS tell all about what is for sale and then bid it off." Prices received have a tremendous effect on RRR, so you must get the top if you want top RRR.

The final step in analysis is to make a schedule of all plus and minus cash flows according to the times of their occurrences and then to calculate real rate of return (RRR). RRRs in each of the two cases we are contrasting are as follows:

RRR = 7.30%

RRR = 6.66%

Note that a $36 lower cost in initial establishment and a $66 higher income from harvest more than offset a $20 higher income from thinning and combined to produce from 363 an RRR nearly 10% higher than that in 680. Planting even more seedlings per acre would have widened the margin. You can also appreciate that the interplay of so many factors at times that may be more than 20 years apart cannot be understood and evaluated without the help of a program like PTAEDA2V+ECONVR.

Now let me go back to regeneration costs. Regeneration is a long complicated process dealing with biology; it starts about August of one year and may not be complete until late November of the following year. It is never close to being as predictable as a computer simulation. Many things can go wrong. A few of them are:

a. Site-prep may not be completely successful, but you won't realize it until November when it is too late to do anything about it;

b. Nursery may have shipped seedlings of the wrong size. Many nurseries don't sort seedlings by size and quality; they ship the contents of the whole bed and expect you to cull the runts.

c. Too many seedlings per acre may have been planted. Members of hand-planting crews invariably tend to converge.

d. Excessive mortality may occur because the seedlings overheated during transport from the nursery, the planters used bad practices, or there was a drought in March or April.

Many contractors offer to carry out each part of regeneration work, and you can usually find one who will do it more cheaply than another. Since high cost is a very big factor in reducing the RRR that will be earned, the proper economy is essential, and the temptation to accept the cheapest price is strong. Our RRR calculation offers a way to resist such a temptation. Before you choose a contractor, ask yourself, "What will be my RRR if this part of my regeneration fails? How does this contractor guarantee his work?" In almost every case, you will find that the penalty for failure is high and that you must be protected against it by a strong guarantee, preferably one that includes cash refunds of some costs.

As a final word on this subject, the price quoted by some contractors may be so low that taking a risk on them is a wise choice, or the productivity of the tract may be so low that no regeneration work will produce an adequate RRR. PTAEDA2V+ECONVR will help you spot such cases.

To continue where I was before this detour, I said earlier that these two analyses utilize only the data developed from the basic PTAEDA2 plots. They do not reflect use of many techniques developed since these plots were installed. Therefore, these two examples show only the effects of planting different numbers of seedlings per acre.

In our 1993 and earlier seminars our scientists, with me as umpire and solely responsible for the result, struggled to estimate how to adjust PTAEDA2 inputs to reflect use of the latest technology. We used these adjustments to develop what we call PTAEDA2V to distinguish it from its predecessor. The result of the presentations and discussions three years ago was the Vardaman 1993 Hypothesis.

To demonstrate the impact of modern technology, I have applied the techniques one at a time and then in combinations to the same basic situation discussed earlier under 65-363. Here is a summary of the calculated RRRs for all plantations included in my presentation:

Now let's use Basic 65-363 as the control and notice several important relationships:

1. As long as planting density was the same, RRR increased with SI. You can see this by looking at the top three figures.

2. If I increased planting density, RRR for any SI decreased. You can see this by comparing each 363 plantation with its counterpart in 680.

3. Except for first-year control of herbaceous competition by itself, all modern techniques increased RRR. Look at A, B, C, and D. Even first-year control of herbaceous vegetation increased RRR when applied in combination with other techniques.

Finally, INCREASES ARE MORE THAN ADDITIVE; THEY'RE MULTIPLICATIVE. Look at B. Use of second-generation seedlings by itself; it increased RRR over 65-363 from 7.30% to 8.86% or 1.56%. In a similar manner C. "big" seedlings by itself increased RRR by 0.28%, and D. chemical site-prep by itself increased it by 0.19%. So the total increases of B + C + D = 2.03%, and adding this to the control 7.30% = 9.33%. On the other hand, using B, C, and D in combination increased RRR to 10.14%, and adding E increased it further to 10.34%.

Please note that what I have just said applies only to the special situation in which the analyzed plantations are located. We might find quite different relationships where, for example, pulpwood prices are very high and sawtimber prices much lower. This means that you must NEVER, NEVER invest in "cookie-cutter forestry," our term for applying the same practices everywhere. If making money were this easy, there would be lots of rich folks. You can only earn the high returns you want by analyzing each opportunity separately, just as you would analyze each stock prior to purchase.

I believe that we have now covered all the factors that affect RRR of modern loblolly-pine plantations. The software needed to process all inputs is now a single program, PTAEDA2V+ECONVR. It will enable us to analyze any plantation in the south. If it's in the planning stage, follow the procedure just as I have set it forth. If it already exists, enter its market value, schedule future cash flow, and calculate RRR to determine its investment potential.

This gives us the essential tool for a use that we haven't mentioned: that of spotting bad investments so as to get rid of them. Many tracts are so inherently unproductive or are located in such poor market areas that they are never likely to be vehicles for making money growing trees. Such tracts occur in every county in the south, but are more common in the small mountains of northeast Alabama and northwest Georgia and the deep sands of northwest Florida, southwest Georgia, and the South Carolina-North Carolina border. Investments almost equally bad are otherwise-productive tracts that have been clearcut but not regenerated. Owners of such tracts may make money from them, but only by artistry, not by growing trees.

Finally, I want to recommend a use that we instituted at the request of Arthur Temple. Arthur said that he probably wouldn't sell any of his investments, timberland or otherwise, but he wanted an informal, annual evaluation of each one as a way of appraising his own performance. We use PTAEDA2V+ECONVR to give him this. We predicted the timber flows when the plantations were established; now all we have to do is apply current timber prices to them and discount them by the appropriate rate for the correct number of years.

I use a variation of his method with my own timber investments, those in which I as an individual or as general partner in limited partnerships buy interests in the timber components of plantations. I'm no better at predicting the future than anyone is, so I really don't have the foggiest idea what timber prices will be 10 to 25 years from now. But PTAEDA2V tells me how much merchantable timber I will have at any time, and the numerous JMV&CO timber sales enable me to evaluate my position continually. Arthur's system is what might be called "marking to market" in timberland, and it helps keep me on my toes. I probably won't follow my original plans exactly, but I'm confident that, sometime during this 15-year period, I will be able to liquidate and earn the planned RRR.

The speakers following me will describe some very powerful modern technology. Tomorrow when we have consolidated all we have learned from them, I think that you will understand why modern plantations are superb investments.